Revisiting credit scores, debt-to-income ratios

I realize that we’ve spoken about credit scores here before. However, with the post-crash lending standards, “good” credit or a “good” credit score doesn’t mean a buyer will be seen as credit worthy or eligible for the advertised low mortgage rates, currently as low as 3.875 percent on a 30-year fixed rate FHA loan (as of Aug. 1).

Buyers typically focus solely on the credit score or the achievement of a particular score level. With achievement of the desired score level, they think a home and those low advertised rates are as good as theirs. While the credit score is always a major focus in becoming pre-approved/pre-qualified for a mortgage loan, it certainly isn’t the only factor lenders will consider when determining a buyer’s ability to purchase.

Credit scores revisited

Before proceeding further, let’s briefly review current credit score requirements. For the most part a credit score of 620 or 640 (the exact level varies from lender to lender) is seen as the standard lowest level credit score for which you will be considered for a mortgage loan. There are a few exceptions to this rule in that there are what we refer to as “hard money” lenders that may consider applicants with credit scores as low as 580, currently seen as the basement floor for the possibility of a mortgage loan. But be prepared for much scrutiny and obviously higher interest rates. For the best rates you’ll generally need a credit score above 700. Scores higher than a 750 don’t seem to buy you any extra advantage.

If you’re a self-employed, commissioned or 1099 income-based individual, you will again be faced with an extra burden of providing proof of the income reported to the IRS generally via tax transcripts for at least the last two years.

income substantiated, the next step is to evaluate your debt to income ratio. The “debt-to-income ratio,” or “DTI ratio” as it’s known in the industry, is the way a lender determines the maximum mortgage payment you can afford. It’s determined by dividing all your monthly liabilities (including the estimated payment with taxes and insurance for your new home) by your gross monthly income, to develop a percentage. This number is known as your DTI, and must fall under a certain percent in order to qualify for a mortgage. The maximum debt-to-income ratio will vary by mortgage lender, loan program and investor. While in the past the qualifying DTI ratio ranged between 40 and 50 percent, with the new qualified mortgage rule, most mortgages now have a maximum back-end DTI ratio of 43 percent.

Of course, getting pre-approved or pre-qualified is just the beginning step. You must stay qualified throughout the process, as all the numbers will be checked again just before closing. So, avoid that temptation to go out and buy new furniture for that dream home or you just may be looking to rent a storage unit to store it in.